October

Lawyers Journal

Qualified sick pay plans prevent IRS headaches

By Jeanne Brutman

October 2012

Many small businesses, law firms and family-owned corporations
do not take advantage of a very important employee benefit called
the "qualified sick pay plan."

This is a plan that will allow an organization to deduct the
wages paid to an employee who is too sick or injured to work.
Without a formal written plan, the IRS does not allow your business
a deduction for these expenses. Every $1 you pay out costs $1.65
($1.81 for S-corporation owners, partners and sole proprietors)
because the IRS views it as an "ad hoc" payment that is not tax
deductible.

Funding a qualified plan is best accomplished through the use of
disability income insurance. This not only allows you to expense
the costs, but a "return of premium" provision can bring your net
cost to almost nothing.

There are several Internal Revenue Codes that deal specifically
with this issue. Internal Revenue Code 105 describes an "accident
sickness plan" as a program for paying employees who gets sick or
is injured. Because they continue the salaries of employees forced
out of work by accident or illness, sick pay plans are included in
this definition. Benefits received under an employer-provided sick
pay plan are taxable, and only a portion of the benefits provided
by the employer are subject to federal income tax. These plans must
be established solely for a firm's employees.

Internal Revenue Code, Section 106, explains that when a sick
pay plan is backed by disability income insurance, premium payments
made by the employer are considered contributions to an accident or
health plan. These payments will not be included in an insured
employee's gross income. Internal Revenue Code, Section 162, shows
how an employer can deduct disability income insurance premiums
paid to support a sick pay plan as an ordinary and necessary
business expense. There are exceptions for S-corporation
shareholders, partners and sole proprietors.

This actually sounds more complicated than it is, and any
representative from a disability insurance company can show you how
to set this up. There are really only two steps in creating a sick
pay plan. The first step is to draft a formal, written plan
document using a disability income proposal, and the second step is
to let participating employees know the plan exists. It is almost
that easy! If your firm has fewer than 100 employees, you might be
exempt from ERISA reporting requirements.

Remember, proper implementation of employee benefits can save
your business money on premiums, give you deductible expenses, and
provide peace of mind. A qualified sick pay plan is a great way to
improve employee loyalty and help you reward and retain key
employees.

Jeanne Brutman, LUTCF, CFBS, CLTC, CFS, is a financial
planner. She can be reached at 212-244-6995 or via email at
[e-mail jeanne].